FOMO or attractive valuation? What drew FIIs back to Indian equities?

The change in their stance, analysts said, stems from the hope that the global central banks, especially US Fed may go soft on rate hikes as inflation cools off over the next few months.

Fear of missing out (FOMO) or fear of losing out (FOLO)? After a few months of relentless selling between October 2021 and June 2022, when foreign institutional investors (FIIs) pulled out over $30 billion from Indian equities, the tide seems to have turned since July — they returned to Indian shores and bought equities worth over Rs 40,000 crore to date.

On a year-to-date basis in calendar year 2022, India saw heavy outflows second only to Taiwan, while Brazil led inflows ($10 billion), suggests a recent report by BofA Securities.

The change in their stance, say analysts, stems from the hope that global central banks, especially the US Federal Reserve (Fed), may go soft on rate hikes as inflation cools off over the next few months.

“In July 2022, emerging-market (EM) funds significantly increased their allocation to India (19.7 per cent versus 18.1 per cent in June 2022), while allocation to China reduced substantially (36.2 per cent versus 39.4 per cent in June 2022). FII inflows (into Indian equities) continued in August 2022, indicating positive outlook for markets, led by India’s better growth prospects amongst large EMs, softening commodity and crude oil prices, and relative outperformance of the rupee within EMs,” wrote analysts, led by head of India research Amish Shah, at BofA Securities, in a co-authored note.

This, coupled with buying by domestic institutions and retail investors, saw front-line indices — the S&P BSE Sensex and the Nifty50 — notch up double-digit gains since July to date.

The market correction in the past few sessions, according to Chokkalingam G, founder and chief investment officer at Equinomics Research & Advisory, is on account of profit-booking as the markets had run up sharply since July. Moreover, the commentary by major global central banks on inflation and rate hikes have also dented market sentiment.

“The reversal in FII flows in July was on account of attractive valuations of Indian equities. The Nifty trades at around 18x one-year forward earnings now, compared to its long-term average of 21x. Also, FIIs did not want to miss out on being invested in Indian equities at a time when the global economy was on the mend in the backdrop of a possibility of inflation cooling off. That said, I believe the major sell-off of Indian equities by FIIs is over. A mild correction was expected and would be a good opportunity to buy. A risk to this view is any possible war in Taiwan and aggressive asset reduction by the Fed,” says Chokkalingam.

Another variable to track FII flows into Indian equities, according to V K Vijayakumar, chief investment strategist at Geojit Financial Services, is the movement of the dollar index. He believes FIIs are unlikely to buy aggressively in the present context of a rising dollar.

“The dollar index is back above 108 and the US 10-year bond yield is at 2.99 per cent. This is negative for capital flows into EMs. India’s impressive gross domestic product growth and favourable leading indicators in the context of global growth slowdown have the potential to attract greater FII flows, but rising dollar and bond yields are strong headwinds. Investors have to exercise caution. Investors can buy high quality banks on declines from a medium-to-long-term perspective. Capital goods and automotive, too, are on a strong wicket,” he observes.